What is the importance of portfolio rebalancing?

Summary: A well‑designed portfolio does not stay that way on its own. Market ups and downs constantly change your equity–debt mix, often making your investments riskier than intended. Portfolio rebalancing is the discipline of bringing your allocation back to what suits your goals and risk tolerance.

How important is rebalancing one's portfolio? – Arjun

At the heart of rebalancing is a simple idea: you start with a target allocation, say, 60 per cent in equity and 40 per cent in fixed income). Markets move, so these weights change.

Rebalancing means selling a bit of what has become too much and buying what has become too little to restore your original portfolio mix.

For example, consider a retiree who invests half of her money in equity funds and half in fixed‑income instruments. If equity markets fall, her 50 per cent equity allocation may slip to 45 per cent. To rebalance, she must move money from fixed income into equity to restore the original 50:50 mix. When markets recover, she benefits because she bought more equity when it was cheaper.

The reverse also applies. If a strong rally pushes equity far above the original allocation, rebalancing means booking some profit in equity and moving it to safer fixed income, so that a future correction does not damage her finances disproportionately.

Rebalancing is therefore not about guessing market tops and bottoms. It is about maintaining your chosen risk level, whatever the market is doing.

Why rebalancing has become crucial, especially after 2020?

The period since 2020 is a textbook case of why rebalancing matters:

• In 2020, after the Covid‑19 shock in March, the Nifty 50 fell sharply and then rallied about 73 per cent from its March low to late November, ending the year with a gain of around 15 per cent.​
• The Nifty 50 Total Return index has delivered strong calendar‑year returns in 2019, 2020, 2021 and 2023, with relatively low returns in 2022 as markets digested earlier gains.​
• By mid‑2022, a difficult year, 83 per cent of Nifty 500 stocks were giving negative returns, showing how broad‑based the correction was outside a handful of large names.​
• After a roaring run in 2023–24, mid‑ and small‑cap indices corrected sharply, with mid caps and small caps falling about 21 per cent and 25 per cent, respectively, from their September 2024 peaks by February 2025. Small‑cap indices have at times been down around 20-25 per cent in a year even when large caps fell much less.​

In such phases, a portfolio that began as, say, 60:40 can easily turn into 75:25 after a big rally or 45:55 after a deep correction, without the investor doing anything.

Rebalancing forces you to sell a little of what has run up (equity after a strong rally) and add to what has lagged (equity after a big fall, or fixed income when yields are attractive). This is the opposite of what most investors instinctively do – they sell in panic after a fall and invest enthusiastically after a big rise.

When should you rebalance?

There are two practical ways to decide when to rebalance. You can use one of them or a combination of both.

#1 Calendar‑based rebalancing

Here, you rebalance once a year (or, for very large portfolios, at most twice a year).

• For most investors, annual rebalancing is enough. It keeps transaction costs and tax impact manageable and ensures that big drifts are corrected.​
• This also fits well with an annual portfolio review, where you reassess goals, time horizons and any life changes (such as nearing retirement or a big upcoming expense).

This simple rule would have helped immensely in the last few years. An annual review at the end of 2020 and 2021, after strong market performance, would have led many investors to trim equity and move some gains into safer assets, reducing the pain of subsequent corrections.​

#2 Threshold‑based rebalancing

Here, you allow some leeway and rebalance only when your allocation drifts beyond a pre‑decided band, say whenever any major asset class moves more than 5 percentage points away from its target (for example, equity moves beyond 65 per cent or below 55 per cent when the target is 60 per cent).

Given the sharp moves seen in mid and small caps since 2023, such a band would have been triggered a few times, prompting investors to book profits after strong rallies in smaller stocks and add selectively during the 2024-25 corrections.​

For most individuals, the below combination works well:

• Do a full check once a year.
• In between, if markets move dramatically and you see a very large drift, consider an interim rebalance.

How much should you rebalance?

Rebalancing does not mean wholesale restructuring every time markets move. The goal is simply to move back towards your target range, not to fine‑tune every decimal place.

Here is a sensible approach to help you understand how to rebalance correctly.

• When equity is modestly above your target, direct fresh SIPs and lumpsum investments into debt rather than equity until the allocation comes back into range.
• When equity is significantly above target (say 70-75 per cent instead of 60 per cent), you may, book some profit in equity funds, ideally beginning with overlapping or redundant schemes or funds that have run up sharply and now form an outsized part of the portfolio. You can also consider shifting the proceeds into appropriate fixed‑income options (short‑duration, high‑quality funds or reliable fixed‑income products).
• On the downside, when a correction pushes equity well below target, you can either deploy part of your fixed‑income allocation into equity or increase your SIPs temporarily, if cash flows permit.

Remember, rebalancing is about maintaining your chosen risk profile, not maximising returns from every move.

Real‑world rebalancing across recent market cycles

To make this concrete, consider three recent phases and what a disciplined rebalancing strategy would have done.

#1 The 2020 crash and sharp rebound

• Markets fell sharply in March 2020 amid Covid‑19 fears, but then recovered so strongly that the Nifty 50 was up about 73 per cent from its March lows by late November 2020, finishing 2020 with a 15 per cent calendar‑year gain.​
• Investors who continued their SIPs and rebalanced annually would have:
  • Added equity in March-April 2020 when valuations were more attractive.
  • Trimmed some equity after the sharp rebound, restoring their original asset mix.

Those who did nothing saw their portfolios become far more equity‑heavy by end‑2020 and 2021, exposing themselves to greater downside risk when conditions turned choppy later.​

#2 The 2022 correction

• While 2020 and 2021 were strong years, 2022 was much tougher. The Nifty 50 TRI delivered relatively low returns compared with the preceding boom years.​
• The pain was more severe outside the largest companies: about 83 per cent of Nifty 500 stocks were giving negative returns by mid‑2022.​

A portfolio rebalanced annually at the end of 2021 would have trimmed some equity exposure at elevated levels, especially from mid and small caps, and moved that money into fixed income. When 2022 turned out to be rough, this investor’s losses would likely have been smaller than a portfolio that stayed heavily tilted towards the winners of 2020–21.

#3 The 2024–25 mid‑ and small‑cap volatility

• After spectacular gains in 2023 and parts of 2024, mid‑ and small‑cap indices corrected sharply from late 2024 into early 2025. An analysis of this period notes that from the September 2024 peak, one major large‑cap index slipped around 15 per cent, while mid‑ and small‑cap indices fell roughly 21 per cent and 25 per cent, respectively, by February 2025.​
• Another commentary on small‑caps highlights a 25 per cent plunge in the small‑cap index, sparking widespread concern.​

In this environment:

• Investors who had allowed small caps to balloon far beyond their planned allocation felt disproportionate pain.
• Investors who capped small‑cap exposure (for instance, 15–20 per cent of overall equity, or 25–30 per cent of the total portfolio) and rebalanced periodically,
  were better positioned. They booked profits when small caps overheated and had both psychological comfort and dry powder to add selectively during the correction.

These episodes underline a simple truth: you cannot control markets, but you can control your allocation.

A practical action plan for rebalancing

Here is a straightforward framework that works for most investors.

Step 1: Define your target allocation

Your starting point is asset allocation aligned with your goals, time horizon and risk tolerance.

A broad rule‑of‑thumb (to be customised):

• Long‑term goals (10+ years): Largely equity‑oriented, with a defined fixed‑income cushion.
• Moderate‑term goals (3-7 years): Balanced or conservative hybrid allocation.
• Short‑term goals (under three years): Primarily fixed‑income and cash‑equivalents.

Value Research’s own guidance on portfolio construction and retirement planning repeatedly emphasises the importance of having a clear equity-debt mix, with mid‑ and small‑cap exposure capped within reasonable limits and some fixed‑income allocation even for aggressive investors. 

For more on this, you can explore long‑standing pieces such as Portfolio Rebalancing and Rebalancing Portfolios.​

Step 2: Fix a rebalancing rule

Decide once, follow it every year:

• Calendar rule: Review and rebalance once a year.
• Threshold rule: Rebalance if any major asset class moves more than 5 percentage points away from target.

Write this down in your investment plan; this reduces the temptation to override it emotionally when markets are euphoric or fearful.

Step 3: Use flows intelligently

To reduce tax and transaction costs:

• Use new investments and SIP increases primarily to rebalance:
  • If equity is underweight, direct more of your new money into equity funds.
  • If equity is overweight, route fresh flows into debt funds or fixed‑income options.
• Reserve actual switches and redemptions for situations where:
  • The drift is large and cannot be fixed through new flows alone, or
  • A particular fund has become redundant or sub‑par.

Our coverage of portfolio trimming and decluttering repeatedly advises that investors should consolidate overlapping schemes and use such consolidation opportunities to rebalance rather than chasing every short‑term winner. 

For practical guidance, see Mutual fund investing: How to trim your portfolio? and Cut the clutter: A step-by-step guide to trim your portfolio.​

Step 4: Prioritise what to sell and buy

When reducing equity exposure, consider first:

• Funds with overlapping portfolios.
• Schemes with weaker long‑term track records or higher expenses.
• Maintain exposure to consistent, well‑run funds that anchor your portfolio.

When increasing equity, invest more in:

• Diversified large‑cap or flexi‑cap funds.
• Quality mid‑cap exposure within limits, rather than concentrated sector bets.​

On the debt side:

• Favour high‑quality, short‑ to medium‑duration funds rather than stretching for yield.

Step 5: Stick with the plan, especially in volatile years

The most important part of this plan is behavioural:

• When markets are down and news flow is scary, your rule may tell you to add to equity. This feels uncomfortable but is built on decades of data showing that systematic investing and maintaining allocation work over time.​
• When markets are euphoric and everyone around you is boasting of quick gains, your rule may ask you to trim exposure. This can feel like missing out, but it is how you preserve capital for the next cycle.​

Rebalancing is, in a sense, a commitment to your future self that you will not allow today’s emotions to derail your long‑term plan.

How to track portfolio drift in practice

Tracking rebalancing manually across multiple folios, brokers and family members can be painful. This is where technology can make the discipline easy.

#1 Use an integrated portfolio tracker

The Value Research Portfolio Manager lets you:​

• Consolidate mutual funds, stocks, NPS and more in one place.​
• Import transactions automatically and capture corporate actions such as dividends, bonuses and splits.​
• View asset allocation across equity, debt and other categories, as well as sector and market‑cap diversification.​

And if there are any areas that require attention, the analysis section of My Investments highlights them for you. For instance, if there is heavy concentration in a single sector or suggesting that allocation to a particular asset class is too high, it will help you take the necessary action to bring your portfolio back to its desired allocation.

#2 Set up periodic reviews and alerts

Practical ways to ensure you act on your rebalancing rules:

• Block a fixed date every year (for instance, just after the end of the financial year) for a full portfolio review.
• Use calendar reminders or task‑management apps to notify you if equity allocation crosses a pre‑set threshold (for example, 70 per cent of your financial assets).
• Use the overview and performance views in Portfolio Manager for a quick ‘sense check’ and detailed analysis.​

Using these resources alongside your portfolio data makes it far easier to translate theory into action.

Why discipline still matters in 2026

As of early 2026, Indian equities are not in a deep bear market, but nor are they as cheap as they were in March 2020. In this setting, rebalancing is more relevant than ever:

• If your equity allocation has crept up after the post‑Covid rally and 2023–24 gains, trimming some exposure to restore your plan can protect you from an adverse surprise.
• If you have under‑allocated to equity because of fear after recent volatility, a controlled increase towards your target can help you participate in long‑term growth, while fixed‑income still provides stability.​

The message is simple: let your asset allocation, not market noise, drive your decisions.

Also read: How and when to reset investments to maximise wealth

This article was originally published on September 02, 2019, and last updated on January 15, 2026.